As we march through the second quarter of the year, we are continuing to see heightened market volatility with an eye toward the timing of the Federal Reserve’s interest rate lift-off, along with focus on corporate earnings. Thus far in earnings season, we’re seeing roughly three-fourths of the S&P 500 companies beating estimates on bottom-line earnings with less than 50% beating on revenue. This revenue beat percentage is lighter than it’s been in recent years. With the multiple on the S&P 500 at the higher end of its historical range, we’re experiencing an asset class rotationthat may or may not be here to stay. Thus far we’ve seen doubledigit returns in many of the international markets, including the EAFE (Europe, Australasia and the Far East) index, as well asthe Emerging Market index. From a style standpoint, we are consistently seeing growth outperform value across many asset classes. When heightened volatility persists, such as the case thus far in 2015, Krilogy clients benefit from our Dynamic Rebalancing process. This process allows us to maintain asset allocation discipline in trimming gains in positions that are extended and add to positions that are oversold.
All Krilogy Portfolio Models undergo forward-looking stress testing as part of our ongoing due diligence that focus on both bearish and bullish outcomes. This process serves as one of many validation procedures that we use to ensure proper asset allocation and individual investment implementation, per each risk tolerance. There are ever-changing risk scenarios that make headlines and our stress testing process provides Krilogy’s Investment Committee and your Krilogy advisor with analytical tools not available to most investors. The portfolio models have been stress tested against a number of scenarios over the past quarter, including:
- What if the S&P 500 suffers a correction in valuation down to long term average levels (from 27 CAPE (cyclically adjusted Price to Earnings) to 16 CAPE?
- What if low interest rates and a growing economy enable the S&P 500 to sustain higher levels of market valuation, near or at all-time highs?
- What if Europe’s bailout and QE schemes fail, leading to a recession and a crashing euro?
A big debate thus far in 2015 has been whether the consumer will spend their savings at the gas pump. Thus far, based on Q1 GDP, it doesn’t appear to be the case. The market is weighing whether the consumer is holding back or if it’s just more of the same with a weak Q1 GDP print, as the annualized GDP rate for the first quarter over the last 30 years is less than 2%. Another primary focus that has grabbed the market’s attention and perhaps the prevailing theme is the timing of the Federal Reserve’s gradual increase in interest rates. The Fed has been consistent
in its emphasis on being data dependent for this decision, but with the labor market getting tighter, wage growth pressures mounting, and signs of inflation beginning to increase, we believe we can expect to see an increase in the latter part of the year. Further, if the Fed continues its transparency and moves in the gradual nature expected, we don’t foresee the eventual series of Fed Funds rate increases as being a significant headwind for equities. Despite the dovish Fed that we’ve seen in recent years that is about to embark on rate tightening, we’re witnessing a variety of different forms of Quantitative Easing across the globe, including Europe, Japan, and China. These efforts are designed to either moderate a slowdown and/or boost growth. Thus far in 2015, we’re seeing the international equity markets react favorably, not too differently than US equity markets during our period of Quantitative Easing. Although many Market Strategists indicate that equities are believed to be more attractive than bonds, despite being on the higher end of historical valuations, it’s important to realize that all bonds are not created equal and great diversification exists within the bond market. Furthermore, in an effort to maintain proper risk tolerance, most investors need some type of fixed income exposure in an effort to achieve their financial goals and objectives.